Option Greeks

Options and Greeks are simply mathematical short forms, which most of you would
remember from school that mathematical formulas sometimes were Greek letters
like Pi and Delta. The same is true for options. Don’t let them overwhelm you or
scare you. They’re simply mathematical words to explain some very basic
principles.

Greeks Describe the Behavior of Individual Options. Each Greek can help predict
how it will behave under different circumstances and how options prices would
change.

Greeks explain why premium gain or lose value. All most all successful traders
correctly use one or more of them - even if the trader doesn’t realize it. The four
most important options Greeks: Delta, Gamma, Theta and Vega.

Delta: Direction

Delta is the most basic and important of all the Option Greeks. Delta shows how
much an option tracks its underlying. Delta is basically a tracker for your
underlying movement or that’s why direction. Delta is positive for calls and
negative for puts.

If a nifty call has a delta of 0.50, it will increase 0.50 in value when nifty rises by 1
point, if nifty put has delta of -0.50, it will increase 0.50 in value when nifty falls
by 1 point. When options are sold, you simply multiply the delta by -1.

Therefore, selling puts is delta positive and you make money from the nifty rising.
This is why traders sometimes speak of being “long delta” or “short delta.” Also,
because options are cheaper than the underlying, delta is the main source of their
leverage.

Gamma: Gaining Delta (Direction) But delta can be tricky because it changes when
an underlying move. That’s why we have gamma or as we call gamma hulk. Gamma
shows how much delta an option gains or loses when the underlying fluctuates.

Gamma shows the absolute or simple change in delta for an option based on the
underlying moving by 1 point. Gamma can be understood as “leverage on
leverage.” Maximizing it effectively can help minimize capital at risk.

Let’s say a call has 0.5 delta and 0.10 gamma and underlying rises by 10 point. The
call not only increases 5 because of its positive delta. Along the way higher its
delta rises to 0.60, resulting in a gain of more than 5.

When a trader correctly anticipates an underlying’s direction, gamma will inflate

their delta. That means their leverage may increase. Unlike holding shares, their
profits won’t be a straight diagonal line up, but a steepening slope.
 Option Greeks
Vega: Volatility

Vega is how much an option changes in value when implied volatility changes on
underlying. Vega is expressed in decimals of premium per percentage points of
implied volatility. Vega is higher on longer-dated options and lower on shorter-
dated options. Say an option has 0.50 Vega and the underlying implied volatility
increases by 1 percentage point. All else being equal, the premium will increase by
0.5. Remember that implied volatility shows how much the market thinks the
underlying will move.

As a result, it tends to increase before big events like earnings or RBI Police - even
if the underlying itself drifts sideways. Implied volatility can then drop quickly
after the news occurs, which is known as a “volatility crunch.”

This trend is the basis of many strangle and straddle trades or short volatility
trades. Implied volatility can also rise when underlying falls sharply. That can
inflate the value of options after a sell off, this also provide the basis for some
“short volatility” trades, like PUT selling. In all these cases, Vega is the key
number to watch when it comes to implied volatility. Traders wanting exposure to
implied volatility may want contracts with more Vega.

Theta: Time Decay

Theta is how much time value an option loses each day. Theta is always a negative
number because of time decay. Theta is greater (a bigger negative number) for shorter-
dated contracts. Theta is expressed in decimals. Theta works against long positions and
favors short positions. Theta increases as expiration approaches. An option with - 0.1
theta will lose 0.10 of value each day, all else being equal.
Time decay is one of the biggest challenges for a lot of traders because it can erase the
value of their options-even when they correctly anticipate the direction underlying is
moving. This is especially true because theta accelerates closer to expiration.
Favouring longer-dated options is a way to avoid this problem. Even though they cost
more, there’s more time for a position to play out and move as expected. Traders looking
to sell options, however, will often select contracts with more theta as they can lose value
more quickly.

In conclusion, Option Greeks may seem confusing. But understanding them is a huge
benefit to traders.

Delta: “direction”
Gamma: “gaining delta”
Vega: “volatility”
Theta: “time decay”